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Mand a toolkit due diligence
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Mand a toolkit due diligence
Dec 29, 2012
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Transcript of "Mand a toolkit due diligence"
1. M&A TOOLKIT Closing: Due Diligence© 2007-2013 IESIES Development Ltd. All Ltd. Reserved © 2007-2013 Development Rights All Rights Reserved
Poor due diligence is the fastest way to destroy a companyA CAUTIONARY TALE: THE DISTINGUISHED HISTORY OF FERRANTI 1882 Founded in London, championing AC power 1887 Designed the first modern power station in the world 1910 Amassed 176 patents in electronics World War II Heavily involved in the early development of radar 1955 The first European company to produce a silicon diode 1987 Ferranti purchased International Signal and Control (ISC), a Pennsylvania based defence contractor for $1.1 billion for cash • Unknown to Ferranti, ISCs business primarily consisted of illegal arms sales started at the behest of various US clandestine organizations • On paper the company looked to be extremely profitable on sales of high-priced "above board" items, but in fact these profits were essentially non-existent • With the sale to Ferranti all illegal sales ended immediately, leaving the company with no obvious cash flow 1993 The massive financial and legal difficulties that resulted forced Ferranti into bankruptcy in December 1993 © 2007-2013 IES Development Ltd. All Rights Reserved
More recently, Ken Lynch, CEO of Bank of America lost his job after conducting due diligence on Merrill Lynch over a weekend……LYNCHED AT MERRILL…Bank of America shareholders should be asking why their companys due diligence process allowedit to undertake a takeover valued at $50bn last September for a business that made an operating lossof $15.5bn in its first quarter of ownership.….Now, not surprisingly, Bank of America’s shareholders are paying the price. Since Mr Lewis agreedto the Merrill deal during the fateful weekend of September 15, Bank of America’s stock has crashedto about $7 per share, down a whopping 80 per cent from the $34 a share the stock was trading atthe day before the Merrill deal was announced, and 40 per cent so far in 2009. Bank of America’stotal market value is now less than the $50bn it offered for Merrill’s stock last September.….Mr Lewis defended his decision to complete the Merrill Lynch takeover on January 1 as being “inthe best interest of our company and our stockholders and the country to move forward with theoriginal terms and timing” of the deal. But it is going to be increasingly difficult for Mr Lewis tocontinue to defend such a horrific failure of due diligence. Some are already calling for his head. “Thething is unravelling so fast Mr Lewis may know his job is lost” FT, January 28th © 2007-2013 IES Development Ltd. All Rights Reserved
Due diligence has three main purposesTHE PURPOSE OF DUE DILIGENCE1) Confirm your “As Is” business value • You understand the business/industry drivers • Restate target P&L to get an accurate baseline • Incorporate detailed analysis in your forecasts2) Prove your Value Hypothesis • Are your synergy assumptions realistic? • Can you see how to realise them in merger integration?3) Find “booby traps” • What is the downside of all potential liabilities? • Do assets exist and are owned? • What don’t you know that you don’t know? © 2007-2013 IES Development Ltd. All Rights Reserved
You can use a checklist to conduct general due diligenceDUE DILIGENCE CHECKLIST FINANCIAL P&L Assets (e.g. cash position) Liabilities (e.g. pensions) TaxationLEGAL Contracts and Commitments Ownership and Control of the Company IP (Patents, trademarks, licences, copyright) Compliance Litigation EnvironmentalBUSINESS Operations Reports Organisation Employees, Benefits, Pensions © 2007-2013 IES Development Ltd. All Rights Reserved
In addition, every business has different ways to “dress-up” a business for sale that due diligence has to identifyWAYS TO DRESS A BUSINESS UP FOR SALE Inflated revenues •Stuffing distribution channels •Sale-or-return agreements •One-off sales classified as recurring Depressed costs •Cost taken outside the books •Recurring costs classified as one-off Underinvestment in the lead-up to sale •Below maintenance capital expenditure •Switching marketing spend from brand building into promotions •Organisation under-invested (e.g. many vacancies) Optimistic projections for new businesses, markets, products etc © 2007-2013 IES Development Ltd. All Rights Reserved
Ways to pump short term profitsINDUSTRY HOW TO PUMPFMCG •Stuffing distribution channelsFinance •Extend depreciation period – change in accounting policyProf services •Booking profit before – revenue recognitionAirlines •Mothballing aircraft •Change depreciation •Release provisions •Sell treasury bonds •Acquisition goodwill/write-offsFactoring •Selling receivables •Vs Ownership •Cost bookingBank •Liabilities off balance sheet •Lower provisions •Non mark to market •Reclassify assets © 2007-2013 IES Development Ltd. All Rights Reserved 6
There is a big difference between conducting due diligence on a Western listed vs a Chinese private company Buying a Western Listed Company Buying a Chinese Private companyDue Diligence starts Public Tender Offer Heads of TermsafterTimescale Strict timetable: 2-3 weeks Flexible: MonthsAccess Dataroom only Whatever negotiatedAudited accounts Usually reliable Usually less reliableData availability Usually OK Target may need helpKey risks Embedded liabilities Compromised assets (Contractual/Litigation/ Guanxi value Pensions/Environmental) Lack of titles/contracts Poor data/financials Related partiesIndemnities and Listed: WYSIWYG Only effective with deferredWarranties payment © 2007-2013 IES Development Ltd. All Rights Reserved
You can include Reps, Warranties and Indemnities in the SPA for a private company if you find something unpleasant in due diligenceACTION AFTER DUE DILIGENCEListed target Continue bid Reduce price Walk away Private target The above, plus include in the Share Purchase Agreement: • Representations (Reps) – Promises from the seller about the situation today • Warranties – Promises about the future • Indemnities if promises breached (could be 10% of price held in ecsrow for 1 year) © 2007-2013 IES Development Ltd. All Rights Reserved
Key points on due diligence• Poor due diligence is the fastest way to destroy a company… ……even a small deal can bankrupt a large company• In due diligence you are looking to - Confirm your “As Is” valuation - Prove your value hypothesis - Find and disarm booby traps• For listed companies, WYSIWYG• For private deals, use your full negotiation scope post-due diligence• Employ good local lawyers and accountants who know the target business…..this is not a place to cut corners © 2007-2013 IES Development Ltd. All Rights Reserved